It’s not uncommon for two people to set up a company and, in a spirit of fair play, to take equal shareholdings in that company. There is no problem while all is going well and they agree about how to take the business forward.

Difficulties arise when they cease to be able to agree on things. Then there is stalemate or deadlock. One of the purposes of a shareholders’ agreement is to provide a resolution for that deadlock.

The solutions normally adopted are based on one of the shareholders taking complete control of the company and the other giving up his shareholding (at a price).

None of the solutions is an easy way out; all of them involve an element of risk and either party may be the winner or the loser. But the draconian nature of the solutions may sometimes help the shareholders to reach some sort of compromise rather than adopt one of the solutions.

The usual solutions are:

Russian Roulette

One of the shareholders gives the other notice requiring the other to sell his shares at a price specified in the notice. If the other shareholder does not want to sell, he is obliged to buy the shares owned by the party who gave the notice at the price specified in the notice. This gives the shareholder who serves the notice an incentive to offer a realistic price unless he knows that the other shareholder is unable to buy his shares. In that case he may offer a low price.

The instigator of the game of roulette may start out with the intention of becoming the sole owner of the company only to find that he has to sell his shares. The other party is faced with the decision of selling out or being obliged to buy the other owner’s shares, leaving him in the invidious position of having to raise the funds to buy the other shareholder out at relatively short notice.

The advantages of this mechanism are that it provides a quick solution to the deadlock and does not involve appointing a third party to value the shares. Its disadvantage is that it may encourage a shareholder to engineer a deadlock.

Reciprocal Put and Call Options

Under a put option one shareholder is obliged to sell his shares to the other shareholder. Under a call option one shareholder is obliged to buy the other shareholder’s shares.

The shareholders’ agreement will set out the method of valuing the shares if one of the shareholders serves notice exercising the option.

This solution favours the shareholder who is prepared to take the initiative; he can decide whether he wants to buy out the other shareholder or whether he wants to be bought out.

An issue for both parties is that the valuation mechanism may not produce a price for the shares which they like.It’s possible that one of the parties may use this mechanism even where there is no deadlock unless the shareholders’ agreement makes it clear that it may only be used in a deadlock situation.

Texas or Mexican Shootout

Both parties submit a sealed bid to an auctioneer. The shareholder who has offered the highest price for the other’s shares buys the other’s shares.

Winding Up

This allows either shareholder to service notice requiring the company to be wound up. Obviously this is a drastic measure and not one to be taken without a full consideration of the tax consequences for the company and the shareholders.

A variation on this is for the shareholders’ agreement to provide for a winding up if no sale is completed under the put and call options.

A winding up may be the only viable solution where the shareholders’ involvement in the company is personal and assets which they have made available to the company are to be returned to them.

Other Possibilities

Chairman’s Casting Vote: The company’s articles may give the chairman a casting vote. The disadvantage in this is that the shareholder who is the chairman of any meeting will always be able to outvote the other shareholder. Few two shareholder companies want to start off with that imbalance.

Independent Third Party: The shareholders could appoint an independent non-executive director, but it may be difficult to find someone willing to take on that role.

Arbitration or Expert Resolution: This is often seen as the solution to all ills, but in reality it will only work where there is a dispute as to some fact, rather than a difference of opinion on how the business should be taken forward (where the is no 'correct' answer).

Alternative Dispute Resolution: This may work whether both shareholders want to find an amicable solution but need the help of an independent facilitator to reach agreement on how to take the business forward or on how to part company. If, however, one of the parties is awkward and there is no goodwill between them it is unlikely to provide a solution to the problem.

Escalation of Disputes: If the two shareholders are companies rather than individuals, the issue may be referred to senior members of each company’s board. Of course, they may not be able to agree either. This should only be an interim step and another method of resolving the deadlock needs to be included in the shareholders’ agreement in case this doesn’t work.

Contact Details

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This article is not intended to be, and should not be taken as being, legal advice. The law often changes and it varies from jurisdiction to jurisdiction; the information in this article is generic in nature and specific legal advice should be taken before acting on any of it.